• 16Nov

  Why Rule 419 Companies May Revitalize the Small-Cap Market

  Securities Law Firm No Comments

  Are Rule 419 Companies poised to be the next big thing in the small-cap sector?

  Recently, the small-cap and reverse merger market has diminished substantially. Operating businesses are wary of completing reverse mergers, and PIPE investors are harder to come by. The reasons for this are easily identifiable.

  First – The General State of the Economy

  Simply stated, it’s not good.

  Second – The Backlash from a Series of Fraud Allegations, SEC Enforcement Actions, and Trading Suspensions of Chinese Company’s Following Reverse Mergers

  Chinese company reverse mergers dominated the shell company business for years; now there are none.  Moreover, it is unlikely that this area will recover any time soon. The Chinese government and US regulators must reach agreement and a mutual understanding regarding PCAOB review of Chinese audits.  Even then, it may take years for the stigma to fade.

  Third – The Rule 144 Changes Enacted in 2008

  As discussed in previous blogs Rule 144(i), as amended, provides in pertinent part that the Rule is unavailable to issuers with no or nominal operations or no or nominal non-cash assets.  That is the rule is unavailable for the use by shareholders of any company that is or was at any time previously, a shell company.  In order to use Rule 144, a Company must have ceased to be a shell company, be subject to the reporting requirements of section 13 or 15(d) of the Exchange Act; filed all reports and other materials required to be filed by section 13 or 15(d) of the Exchange Act, as applicable, during the preceding 12 months (or for such shorter period that the issuer was required to file such reports and materials), other than Form 8-K reports; and have filed current “Form 10 information” with the Commission reflecting its status as an entity that is no longer a shell company, then those securities may be sold subject to the requirements of Rule 144 after one year has elapsed from the date that the issuer filed “Form 10 information” with the SEC.

  Accordingly, former shell companies must always remain current in their filings (even 20 years after a merger) and the rule will never be available to former shell non-reporting pink sheet company shareholders.

  Fourth – The Problems Clearing Penny Stock with Broker Dealers

  Most (almost all) small cap companies are penny stocks as defined by federal regulations.  A penny stock is a stock that trades below $5.00.  In January 2009, FINRA sent a regulatory notice to its member broker dealers warning that they are obligated to trace the origin of stock certificates back to the original issuers or face hefty fines for failing to complete the due diligence. This process is expensive and time consuming and many broker dealers are just not willing to go through the trouble for a penny stock.  Following the regulatory notice,

  Penson Financial Services, one of the nation’s largest clearing firms, enacted a policy in response to this and will not clear a stock trading below $.10. In addition to this chilling the clearing process, it has had a negative effect on PIPE investors who are concerned about getting their stock cleared and sold.

  Fifth – Issues with DTCC, The Depository Trust & Clearing Corporations

  DTC controls the clearing of all stock in street name and through electronic transfers.  If a company’s stock is not DTC eligible it will be illiquid.  Although DTC has not technically changed its rules, they are enforcing them differently.  DTC is now requiring documents which may not exist or which may be impossible to obtain.  For example, DTC requires the original offering document for public issuances.  For a company that went public 10 years ago, subsequently failed and became a shell, and changed management a dozen times in between such offering document can be unattainable.

  When that same company now wants to complete a reverse merger with a solid operating business, file a registration statement and become fully reporting and transparent, they may not be able to become DTC eligible.  In addition, DTC has been taking a very long time to clear penny stocks, even when the paper work is in order.  Many months or more can go by without communication. DTC has no time limit requirements so an applicant is at their mercy.

  Sixth – Increasing Cost of Reporting Requirements

  As of June of this year, all reporting companies must file their reports using XBRL.  XBRL is an interactive tagging system to provide in-depth information on financial statements.  However, for a shell company, or small public company it may simply be a matter of too much information.  No one will look at it and the cost is high, averaging about $10,000 in the first two years alone.

  Seventh – New Listing Requirements Imposed by NYSE, AMEX and NASDAQ

  The NYSE AMEX and NASDAQ amended its rules so that a Company that goes public via a reverse merger with a shell company must wait at least one year to apply for listing on the NYSE exchange.  The new rule requires that the reverse merger company maintain a post-exchange trading stock price for at least 30 of the most recent 60 trading days prior to the filing of the initial listing application.  In addition to the specific additional listing requirements contained in the new rule, the Exchange may “in its discretion impose more stringent requirements than those set forth above if the Exchange believes it is warranted in the case of a particular reverse merger company based on, among other things, an inactive trading market in the reverse merger company’s securities, the existence of a low number of publicly held shares that are not subject to transfer restrictions, if the reverse merger company has not had a Securities Act registration statement or other filing subjected to a comprehensive review by the SEC, or if the reverse merger company has disclosed that it has material weaknesses in its internal controls which have been identified by management and/or the reverse merger company’s independent auditor and has not yet implemented an appropriate corrective action plan.”  The new listing standards may increase the use of the over the counter markets in a “what else can we do” sort of way, but it also may have a further chilling effect, with operating businesses deciding to go public directly or not going public at all.

  Going Public Direct

  Going public directly may seem like an obvious response to these issues, but it isn’t that easy.  The days of the mid size NASDAQ broker dealers acting as underwriter for any company with revenues are long over.  Most mid size broker dealers won’t underwrite an IPO for a company with less than $40 mil in revenues and even that is a long shot.  Without an underwriter a company going public directly must complete a DPO (direct public offering).  These offerings are extremely difficult to complete.  Public offerings may not be generally advertised and the ability to solicit investors is highly regulated, and restricted.

  Moreover, since a market maker can be deemed an underwriter for filing a 15c2-11 application on behalf of a company completing a DPO, most won’t proceed until the DPO is completely closed out.  A 15c2-11 application is necessary to obtain a trading symbol and have your stock quoted in the aftermarket.  That is, in addition to being limited on who they solicit, the company completing a DPO has to convince investors that eventually, there will be an aftermarket and exit strategy for the investment they make today.

  Going Public by Private Placement

  The same issues are faced by a Company going public directly by completing a private placement following by S-1 resale registration statement.  The investor is taking the chance that the company will never complete the registration statement and an aftermarket will never develop.  Moreover, the SEC has made it clear that a company cannot sell a private placement with the promise of going public.  The SEC has good reasons for this, many of these companies never do and never intend to go public, but for those that are the real deal, it makes the process difficult.

  Rule 419 may provide a good answer.  It won’t solve all the problems, and in particular it doesn’t address the first and second issues discussed above, but it provides a very real solution for the rest.

  As discussed in previous blogs, the provisions of Rule 419 apply to every registration statement filed under the Securities Act of 1933, as amended, by a blank check company.  Rule 419 requires that the blank check company filing such registration statement deposit the securities being offered and proceeds of the offering into an escrow or trust account pending the execution of an agreement for an acquisition or merger.

  Form 10 Registration Statements

  In addition, the registrant is required to file a post effective amendment to the registration statement containing the same information as found in a Form 10 registration statement, upon the execution of an agreement for such acquisition or merger.  The rule provides procedures for a reconfirmation offering allowing the initial investors to decide whether or not to stay in the deal following receipt of the Form 10 information on the operating business.  If 80% of the shareholders do not agree to the merger and stay in the deal, it does not go though.  Rule 419 is the only way to create a blank check company for the purpose of completing a reverse merger with an operating business.

  Eliminating the first two issues discussed above, and the issue of reporting expenses, here is how Rule 419 can address the other problems.  I will say upfront, Rule 419 does not solve the issue of reporting costs, and in fact, they are a further deterrence as the Rule 419 Company will be subject to reporting requirements, even while the offering proceeds remain in escrow pending a reverse merger.

  Rule 419 Companies Are Not Subject to Shell Company Prohibitions of Rule 144

  First, although technically a shell prior to the completion of a reverse merger, most Rule 419 companies are not subject to the shell company prohibitions in Rule 144(i).  The prohibitions for the use of Rule 144 by shell companies, or former shell companies, do not apply to “a business combination related shell company, as defined in Rule 230.405” (see Rule 144(i)(1)(i)).  A business combination related shell company, is defined in Rule 230.405 as a shell company that is “… (2) Formed by an entity that is not a shell company solely for the purpose of completing a business combination transaction (as defined in Rule 230.165(f)) among one or more entities other than the shell company, none of which is a shell company.”  It seems that a Rule 419 company could easily be created that meets the definition of Rule 230.405 and is thus exempted from the provisions of Rule 144(i).

  Second, a Rule 419 company can easily provide the necessary paperwork to a broker dealer to meet FINRA requirements.  It is a new company, and all shareholders will either have purchased in the 419 offering itself, or will have received their shares directly from the Issuer in the reverse merger transaction.

  Third, and for the same reasons as stated above, DTC clearance should be much easier.  All the documents will be available and easily provided.  All shares traceable and accounted for.   All shares will be registered under the Securities Act of 1933, rather than seeking to trade through an exemption.

  The biggest problem with Rule 419 is the legal and accounting expenses of completing the offering, and post effective requirements to complete the reverse merger.  However, with a knowledgeable attorney and reasonable auditor, the process should go smoothly.

  However, with all of that being said, the boom in 419 Companies may be just around the corner.

  The Author

  Attorney Laura Anthony,
  Founding Partner, Legal & Compliance, LLC
  Securities, Reverse Mergers, Corporate Transactions

  Securities attorney Laura Anthony provides ongoing corporate counsel to small and mid-size public Companies as well as private Companies intending to go public on the Over the Counter Bulletin Board (OTCBB), now known as the OTCQB. For more than a decade Ms. Anthony has dedicated her securities law practice towards being “the big firm alternative.” Clients receive fast and efficient cutting-edge legal service without the inherent delays and unnecessary expense of “partner-heavy” securities law firms.

  Ms. Anthony’s focus includes but is not limited to compliance with the reporting requirements of the Securities Exchange Act of 1934, as amended, (”Exchange Act”) including Forms 10-Q, 10-K and 8-K and the proxy requirements of Section 14. In addition, Ms. Anthony prepares private placement memorandums, registration statements under both the Exchange Act and Securities Act of 1933, as amended (”Securities Act”). Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including preparation of deal documents such as Merger Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of the Exchange Act, state law and FINRA for corporate changes such as name changes, reverse and forward splits and change of domicile.

  Contact Legal & Compliance LLC for a free initial consultation or second opinion on an existing matter.

  Tags: New Reverse Merger Rule, public shells, Reverse Mergers, Rule 144 Exemptions, Rule 419, Rule 419 Companies, Rule 419 Shells, SEC Law Firm, securities attorney, Shell Companies

• 22Jan

  Rule 144 and the Evergreen Requirement Examined

  SEC Law Firm No Comments

  Technically Rule 144 provides a safe harbor from the definition of the term “underwriter” such that a selling shareholder may utilize the exemption contained in Section 4(1) of the Securities Act of 1933, as amended, to sell their restricted securities. In addition, Rule 144 is used to remove the restrictive legend from securities in advance of a sale. In layman terms, Rule 144, allows shareholders to either remove the restrictive legend or sell their unregistered shares.

  Rule 144(i), as amended, provides in pertinent part that the Rule is unavailable to issuers with no or nominal operations or no or nominal non-cash assets. That is the rule is unavailable for the use by shareholders of any company that is or was at any time previously, a shell company. A shell company is one with no or nominal operations and either no or nominal assets, assets consisting solely of cash and cash equivalents or assets consisting of any amount of cash and cash equivalents and nominal other assets.

  Form 10 Information

  In order to use Rule 144, a Company must have ceased to be a shell company, be subject to the reporting requirements of section 13 or 15(d) of the Exchange Act; filed all reports and other materials required to be filed by section 13 or 15(d) of the Exchange Act, as applicable, during the preceding 12 months (or for such shorter period that the issuer was required to file such reports and materials), other than Form 8-K reports; and have filed current “Form 10 information” with the Commission reflecting its status as an entity that is no longer a shell company, then those securities may be sold subject to the requirements of Rule 144 after one year has elapsed from the date that the issuer filed “Form 10 information” with the SEC.

  The Evergreen Requirement

  Rule 144 now affects any company who was ever in its history a shell company by subjecting them to additional restrictions when investors sell unregistered stock under Rule 144. The new language in Rule 144(i) has been dubbed the “evergreen requirement”. The new Rule has the impact of punishing a company that was ever a shell in perpetuity and more importantly, its investors. Brian Breheny, deputy director of the Securities and Exchange Commission’s corporate finance division, referred to the so-called evergreen requirement in Rule 144(i) of the Securities Act, as an “unfortunate result” and said it was “probably not something that the commission intended.”

  Going Public and Reverse Mergers

  Under the so called “Evergreen Requirement”, a company that ever reported as a shell must be current in its filings with the SEC for 12 months before investors can sell unregistered shares. Here is the hitch. As a result, the restrictive legend can never be removed in advance of a sale. The rule affects all companies going public through a reverse merger or SPAC. Moreover, the Rule effects all companies that have ever been a shell, even if a reverse merger was completed decades ago. It paints a “scarlet letter” on all former shell companies, as this requirement continues literally forever – famous former shells like Blockbuster Entertainment, Texas Instruments and Berkshire Hathaway are now burdened by this restriction decades after their reverse mergers.

  So basically, you have to register the shares to get the legend removed. Practitioners have requested that the SEC either amend the Rule or issue additional guidance removing this requirement from Companies that were no longer shells at the time the Rule was enacted. So far no such changes have been made.

  Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

  Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!

  Tags: evergreen requirements, going public, public offerings, public shells, Reverse Mergers, Rule 144, SEC Law Firm, SEC reporting requirements, SEC Rule 144, securities attorney, underwriter defined

• 11Nov

  Rule 144 and Pink Sheet Shells; Selling Shares Post Merger

  Reverse Mergers No Comments

  One of the most common inquiries received by securities attorneys today involves Issuers wanting to know when they and their shareholders can sell their shares on the open market following a merger with a Pink Sheet shell. In many cases, the answer they get is not the answer they want; twelve months after the Pink Sheet Company becomes a fully reporting entity.

  If a private entity has merged with a Pink Sheet shell under the assumption that they can avoid the Securities and Exchange Commission (SEC) reporting requirements, this revelation is devastating. As a result of the amendments to Rule 144 and Rule 145, enacted in February, 2009, private companies that wish to go public on the Pink Sheets are advised to do so directly, and not through a reverse merger with a shell company.

  Rule 144

  Technically Rule 144 provides a safe harbor from the definition of the term “underwriter” such that a selling shareholder may utilize the exemption contained in Section 4(1) of the Securities Act of 1933, as amended, to sell their restricted securities. In layman terms, Rule 144, allows shareholders to sell their unregistered shares. When a private entity merges with a Pink Sheet shell, the shareholders of the private entity receive restricted shares. Historically, other than registration, Rule 144 provided the only method for such shareholders to sell their shares on the open market. The February 2009 amendment eliminated this ability.

  Rule 144(i), as amended, provides in pertinent part that the Rule is unavailable to issuers with no or nominal operations or no or nominal non-cash assets. That is the rule is unavailable for the use by shareholders of any company that is or was at any time previously, a shell company. A shell company is one with no or nominal operations and either no or nominal assets, assets consisting solely of cash and cash equivalents or assets consisting of any amount of cash and cash equivalents and nominal other assets.

  When a Shell is No Longer a Shell

  In order to use Rule 144, a Company must have ceased to be a shell company, be subject to the reporting requirements of section 13 or 15(d) of the Exchange Act; filed all reports and other materials required to be filed by section 13 or 15(d) of the Exchange Act, as applicable, during the preceding 12 months (or for such shorter period that the issuer was required to file such reports and materials), other than Form 8-K reports; and have filed current “Form 10 information” with the Commission reflecting its status as an entity that is no longer a shell company, then those securities may be sold subject to the requirements of Rule 144 after one year has elapsed from the date that the issuer filed “Form 10 information” with the SEC.

  Lastly, Rule 145, which is the rule that addresses the issuance of securities in mergers, consolidations and reclassifications, was amended to provide an analogous provision.

  Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

  Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!

  Tags: form 10 registration statement, form 8-k, going public, pink sheet shells, pink sheets, public shells, registration statement, Reverse Mergers, Rule 144, Rule 145, SEC Law Firm, SEC reporting requirements, securities attorney

• 05Nov

  SEC Rule 144: Pledged Securities, Holding Periods and Subscriptions Agreements

  SEC Law Firm No Comments

  Securities which are bona fide pledged may be tacked to the holding period of the pledgor as long as the pledge has full recourse against the pledgor. Gifted securities may be tacked with the holding period of the donor. Securities transferred to a trust may be tacked with the holding period of the settlor. Likewise securities transferred to a 401(k) or other individual retirement account will tack to the original issuance date. Securities obtained by beneficiaries of an estate may be tacked with the holding period of the deceased.

  Securities acquired solely by the cashless exercise of an option or warrant are deemed to have been issued on the date of issuance of the underlying option or warrant; provided however, that the payment of any consideration, even a de minimus amount of cash, for the newly issued securities will restart the holding period. Accordingly, securities issued upon exercise of options or warrants in a stock option plan are deemed issued upon exercise of such option or warrant and not before.

  Subscription Agreements

  For purposes of Rule 144, shares acquired pursuant to anti-dilution rights attaching to restricted securities are restricted securities themselves, but their holding period dates back to the original placement of shares, not the exercise of the anti-dilution provisions. The holding period for restricted securities acquired pursuant to a subscription agreement begins at the time the agreement is accepted by the issuer, rather than the date it is signed by the purchaser or the date the shares are issued, assuming the full purchase price has been paid.

  When relying on Rule 144 for the resale of over the counter traded securities (Pink Sheets or Bulletin Board), sellers may only sell 1% of the outstanding securities of the issuer in every 90 day period. Calculations of volume restrictions based on trading volume are only available for the sale of exchange traded securities.

  The manner of sale requirements, require that securities sold in reliance on Rule 144 be sold only in broker’s transactions, directly with a market maker or in a riskless principal transactions. Moreover, the person selling the securities may not arrange for the solicitation of sale orders. The posting of a customer limit order is not considered a solicitation for purposes of this rule.

  Finally, and importantly, Issuers and sellers must be aware that Rule 144 is not available for the sale of securities initially issued by a shell company or any issuer that has at any time previously been a shell company unless all the requirements of Rule 144(i)(2) are met. These requirements include that the issuer no longer be a shell company, is subject to the reporting requirements of the Exchange Act for 12 months following the time that it filed Form 10 information indicating it was no longer a shell company, and is current with all Exchange Act reporting requirements.

  Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

  Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!

  Tags: 15c-211, form 10-k, going public, OTCBB, Over The Counter Bulletin Board, pink sheets, public shells, restricted securities, Reverse Mergers, Rule 144, SEC Law Firm, securities attorney, subscription agreements, unrestricted securities

• 04Nov

  SEC Rule 144: Current Public Information and Reporting Requirements

  SEC Law Firm No Comments

  The current public information requirement is measured at the time of each sale of securities. That is, the Issuer, whether reporting or non-reporting, must satisfy the current public information requirements as set forth in Rule 144(c) at the time that each resale of securities is made in reliance on Rule 144. Most attorney opinion letters and Forms 144 cover a three month period and many Sellers sell securities over that three month period. However, the Seller (or person selling on behalf of Seller such as the broker dealer) is required to make a determination that current public information is available at the time of each sale.

  Accordingly, if a reporting issuer does not file a required Q or K during this period, or 15c2-11 information lapses for a non-reporting issuer, sales must cease until the current public information requirement is again satisfied. Moreover, Sellers are taking a risk by selling during the 5-day or 15-day period following the filing of a Form 12b-25 because if the late report is not filed, such sales would not have been made in compliance with Rule 144. On the contrary, if the report is filed, the sales made after the filing of the 12b-25, still satisfy the current public information requirements.

  Non-Reporting Issuers

  For non-reporting issuers, the current public information requirement requires that information set forth in Rule 15c2-11 be publicly available and current. It is irrelevant that broker dealers may publish quotes on the securities or that the securities are piggy-back qualified. Although pinksheets.com is not affiliated with the Securities and Exchange Commission (“SEC”) and the SEC has not commented on the Pink Sheets self-imposed reporting requirements and tiers of reporting information, in light of the fact that the Pink Sheets models its voluntary reporting requirements after Rule 15c2-11, attorneys and sellers of securities, should feel confident relying on the existence of current information on pinksheets.com to satisfy the current public information requirement of Rule 144.

  In lieu of relying upon information posted on PinkSheets.com, a Seller desiring to rely on Rule 144 for the sale of securities of a non-reporting issuer, would need to ensure themselves that such 15c2-11 information was available and current by other means. These other means could include if such information was posted on the Issuers website, or such information was in the possession of the broker-dealer facilitating the sale.

  Holding Periods

  The holding period is determined as of the date of the proposed sale, provided however, that Rule 144 makes numerous specific provisions for the calculation of the holding period and enumerates specific instances when a holding period may be tacked onto the holding period of previously issued securities. In determining the holding period where the securities were paid with a promissory note, installment contract or other obligation to pay in the future, the holding period does not begin until payment has been made in full unless the promissory note or installment contract provides for full recourse against the purchaser of the securities, is secured by fair value collateral other than the securities purchased, and has been paid in full prior to the proposed Rule 144 sale date.

  Securities acquired from the issuer as a dividend or pursuant to a stock split, reverse split or recapitalization shall be deemed to have acquired at the same time as the securities on which the dividend is paid or the securities surrendered in the recapitalization. If securities were acquired by the Issuer solely in exchange for other securities of the same issuer, such as in a 3(a)(9) transaction, the newly acquired securities are deemed to be acquired at the same time as the securities surrendered in the exchange or conversion.

  Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

  Ms. Anthony is the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The firm’s corporate and securities attorneys provide technical legal services to small and mid-size private and public (OTCBB) Companies, entrepreneurs, and business professionals nationwide. Contact us today for a FREE consultation!

  Tags: 12b-25, 15c-211, form 10-k, form 10-q, going public, non-reporting issuers, OTCBB, Over The Counter Bulletin Board, pink sheets, public shells, Reverse Mergers, Rule 144, SEC Law Firm, SEC reporting requirements, Section 3(a)(9), securities attorney

• 21Oct

  The Securities & Exchange Commission (SEC) Provides Guidance Regarding Section 3(a)(10) of the Securities Act of 1933

  Securities Law Firm No Comments

  Section 3(a)(10) of the Securities Act of 1933, as amended (“Securities Act”) is an exemption from the Securities Act registration requirements for the offers and sales of securities by Issuers. The exemption provides that “[E]xcept as hereinafter expressly provided, the provisions of this title [the Securities Act] shall not apply to any of the following classes of securities….(10) Except with respect to a security exchanged in a case under title 11 of the United States Code, any security which is issued in exchange for one or more bona fide outstanding securities, claims or property interests, or partly in such exchange and partly for cash, where the terms and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by any court, or by any official or agency of the United States, or by any State or Territorial banking or insurance commission or other governmental authority expressly authorized by law to grant such approval.”

  The Securities and Exchange Commission (SEC) has given guidance on the operation of Section 3(a)(10) in its Division of Corporation Finance: Revised Staff Legal Bulleting No. 3. In particular, in order to rely on the exemption, the following conditions must be met:

  • The securities must be issued in exchange for securities, claims, or property interests, not cash;
  • A court or authorized governmental entity must approve the fairness of the terms and conditions of the exchange;
  • The reviewing court or authorized governmental entity must (i) find that the terms and conditions of the exchange are fair to those that the securities will be issued to; and (ii) be properly advised that the Issuer will be relying on the court’s findings to issuer securities;
  • The reviewing court or authorized governmental entity must hold a hearing before approving the fairness of the terms and conditions of the transaction;
  • A governmental entity must be expressly authorized by law to hold the hearing;
  • The fairness hearing must be open to everyone to whom securities would be issued in the proposed exchange;
  • Adequate notice must be given to all those persons; and
  • There cannot be any improper impediments to the appearance by those persons at the hearing.

  In addition to complying with the above conditions, Issuers should be aware that many state securities law statutes that authorize a Section 3(a)(10) court process, require that there be a majority shareholder vote approving the transaction, prior to the hearing.

  Importantly SEC Staff Bulletin 3 provides that the re-sale of securities issued in a Section 3(a)(10) transaction may be had without regard to Rule 144 if the seller is not an affiliate of the Issuer either before or after the Section 3(a)(10) transaction. If the seller is or will be an affiliate either before or after the Section 3(a)(10) transaction, re-sales may be made in accordance with Rule 144, except for the holding period and notice filing requirements. That is, affiliates would still be subject to the drip rules, manner of sale and current public information requirements.

  As a practical matter, many over the counter traded securities (Over the Counter Bulletin Board or OTCBB and Pink Sheets) have been utilizing the exemption found in Section 3(a)(10) to convert debt into common stock. The conversion of debt into common stock can assist an Issuer in two ways. First, and obviously, it eliminates the debt from the balance sheet and increases liquidity and solvency. Second, and less obvious, is that the Section 3(a)(10) exemption can be used to convince lenders to make investments into a company, without the investor relying solely on the Company cash flows for repayment.

  Moreover, in these trying economic times, it seems there is the potential for a substantial increase in the use of this exemption by OTCBB and Pink Sheet Companies as a tool to clean up their balance sheets and induce additional capital investments. In fact, the hearing process can be quick and relatively inexpensive. The court must only opine on the fairness of the transaction to those that the securities will be issued, the creditor whose debt will be exchanged for stock.

  The court does not render their decision based upon the potential impact on the shareholders of record, the Company or the potential marketplace shareholders. In most cases the creditor is highly motivated to convert its debt into common stock and realize the opportunity for immediate cash through resale or the opportunity for long-term gain through holding the stock.

  As with the use of all registration exemptions, Issuers are cautioned that they are still subject to the anti-fraud, civil liability and other provisions of the federal securities laws. Moreover, Section 3(a)(10) is not available to exempt any transaction that is in part of a plan or scheme to evade the registration provisions of the Act. In any of these cases, registration under the Act is required unless another exemption is available.

  Securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel to small public Companies as well as private Companies seeking to go public on the Over the Counter Bulletin Board Exchange (OTCBB). Ms. Anthony counsels private and small public Companies nationwide regarding reverse mergers, due diligence on public shells, corporate transactions and all aspects of securities law.

  Attorney Laura Anthony is a Florida securities attorney and the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The Florida corporate and securities attorneys of Legal & Compliance offer specialized legal services to small and mid-size private and public (OTCBB) companies, entrepreneurs, and business professionals throughout the country. Contact us today for a FREE consultation!

  Tags: convertible debt, due diligence, going public, OTCBB, Over The Counter Bulletin Board, public shells, Reverse Mergers, SEC Law Firm, Section 3(a)(10), securities attorney

• 20Oct

  Elements Constituting “Solicitation” Such that a 14A Proxy Solicitation is Required Instead of a 14C Information Statement Under the Section 14 Proxy Rules of the Securities Exchange Act of 1934

  Securities Attorneys No Comments

  If you are a private company looking to go public on the OTCBB, securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel. Ms. Anthony counsels private and small public companies nationwide regarding reverse mergers, corporate transactions and all aspects of securities law.

  Companies with securities registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) are subject to the Exchange Act proxy rules found in Section 14 and the rules promulgated thereunder. The proxy rules govern the disclosure in materials used to solicit shareholders’ votes in annual or special meetings held for the election of directors and the approval of other corporate action.

  The information contained in proxy materials must be filed with the SEC in advance of any solicitation to ensure compliance with the disclosure rules. Solicitations, whether by management or shareholder groups, must disclose all important facts concerning the issues on which holders are asked to vote. The disclosure information filed with the SEC and ultimately provided to the shareholders is enumerated in SEC Schedule 14A.

  In instances when a shareholder vote is not being solicited, such as when a Company has obtained shareholder approval through written consent in lieu of a meeting, a Company may satisfy its Section 14 requirements by filing an information statement with the SEC and mailing this statement to its shareholders. In this scenario, the disclosure information filed with the SEC and mailed to shareholders is enumerated in SEC Schedule 14C.

  As with the proxy solicitation materials filed in Schedule 14A, Schedule 14C information is reviewed by the SEC to ensure all important facts are disclosed. However, Schedule 14C does not solicit or request shareholder approval or any other action for that matter, but rather informs shareholders of an approval already obtained and corporate actions which are imminent.

  The information requirements in Schedule 14C are less arduous in the respect that they do not include lengthy material regarding what a shareholder must do to vote or approve a matter. Moreover, the Schedule 14C process is much less time consuming, as the shareholder approval has already been obtained. Accordingly, when possible, Companies prefer to utilize the Schedule 14C Information Statement as opposed to the Schedule 14A proxy solicitation.

  The SEC requires the use of a Schedule 14A proxy solicitation whenever the Company is making a solicitation of shareholder approval, however small that solicitation. A “solicitation” is defined by Rule 14a-1(l) as;

  1. any request for a proxy whether or not accompanied by or included in a form of proxy
  2. any request to execute or not to execute, or to revoke a proxy
  3. the furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.

  Simply stated, whenever a Company requests a shareholder to consent to action, it is soliciting that shareholder’s approval and accordingly must abide by the Schedule 14A proxy solicitation requirements. According to the exact language of these SEC rules, a Schedule 14A proxy solicitation is required since the Company is requesting a shareholder to vote. In reality, a Company is nothing more than the officers and directors that run it and often these officers and directors are shareholders as well.

  Although the SEC has not issued definitive guidance on the subject, by practice they have taken the position that where required shareholder consent can be had without requesting any shareholders other than the officers and directors of a company to issue such consent, a 14C Information Statement may be used rather than the 14A proxy solicitation.

  That is, a 14C Information Statement is only appropriate where the majority shareholder(s) are comprised of only the officers and directors. This is so even in cases where the majority of shareholders is comprised of a small group of family and friends of officers and directors, or a small group of consultants or other insiders.

  Attorney Laura Anthony is a Florida securities attorney and the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The Florida corporate and securities attorneys of Legal & Compliance offer specialized legal services to small and mid-size private and public (OTCBB) companies, entrepreneurs, and business professionals throughout the country. Contact us today for a FREE consultation!

  Tags: Exchange Act Section 14, going public, OTCBB, Over The Counter Bulletin Board, public shells, Reverse Mergers, schedule 14A, schedule 14C, SEC Law Firm, SEC reporting requirements

• 17Oct

  Necessity of Background Searches on Officers and Directors as Part of Due Diligence Prior to a Reverse Merger or IPO

  Reverse Mergers No Comments

  If you are a private company looking to go public on the OTCBB, securities attorney Laura Anthony provides expert legal advice and ongoing corporate counsel. Ms. Anthony counsels private and small public companies nationwide regarding reverse mergers, corporate transactions and all aspects of securities law.

  Many private companies go public either through a reverse merger with a public shell or initial public offering (IPO) process. A reverse merger allows a private company to go public by purchasing a controlling percentage of shares of a public shell company and merging the private company into the shell. An initial public offering is where the private company files a registration statement with the Securities and Exchange Commission and once the registration statement is effective proceeds to sell stock either directly (a DPO) or more commonly through an underwriter.

  It is very important that management of public shells and underwriters conduct a background check on the private company’s officers and directors prior to embarking on any transaction that will result in a private company becoming public. While a reverse merger saves on the costs associated with going public, private companies must be weary of the intentions of the officers and directors associated with the takeover.

  Within four days of completing a reverse merger of with a shell public company, the company must file a form 8-K which contains all the information that is required in a Form 10 registration statement. Such information includes Regulation S-K Items 401 and 404. This same information must be included in a registration statement filed to conduct an IPO.

  Regulation S-K Item 401 requires public companies to provide detailed information regarding its directors, executive officers, significant employees, promoters and control persons, including, but not limited to, the following:

  • Name, age and positions with the company
  • Family relationships among directors, executive officers, significant employees, promoters and control persons
  • Detailed background, business experience and employment for the last five years
  • Directorships in other public companies;
  • Involvement in any of the following legal proceedings in the past five years:
    1. Any personal or corporate bankruptcy proceedings;
    2. A conviction in a criminal proceeding or being named the subject of a pending criminal proceeding;
    3. Being subject to an order, judgment or decree permanently or temporarily enjoining or permanently or temporarily barring the person from acting as a broker, associated person; investment adviser, underwriter, dealer, affiliated person, director or employee in any way related to the securities or banking business; engagement in any securities related activities or violating any state or federal securities laws;
    4. Being found by a court to have violated any state or federal securities or commodities laws;

  Regulation S-K Item 404 requires public companies to provide detailed information regarding transaction by and among related persons including transactions by and among the company and any of its directors, executive officers, significant employees, promoters and control persons. Moreover, Item 404 requires detailed information regarding how such transactions were reviewed, approved and ratified.

  Clearly it is important for all parties to know well in advance the disclosures that will be required regarding its directors, executive officers, significant employees, promoters and control persons. Moreover, it is important for both public shell companies and underwriters to conduct independent background checks as individuals may not always be forthcoming regarding disclosures such as prior securities law issues and criminal convictions.

  It is generally the responsibility of corporate legal counsel to conduct, or assist in completing, these background searches. The foundation of the due diligence process, and the success of the potential reverse merger or IPO itself, depends upon the meticulousness and accuracy of these various background checks.

  Attorney Laura Anthony is a Florida securities attorney and the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The Florida corporate and securities attorneys of Legal & Compliance offer specialized legal services to small and mid-size private and public (OTCBB) companies, entrepreneurs, and business professionals throughout the country. Contact us today for a FREE consultation!

  Tags: background searches, due diligence, form 8-k, going public, IPO, OTCBB, Over The Counter Bulletin Board, public shells, regulation s-k, Reverse Mergers, SEC Law Firm, SEC reporting requirements, securities attorney

• 15Oct

  Analysis of Section 404(b) of the Sarbanes-Oxley Act of 2002 for Non-Accelerated Filers

  SEC Law Firm No Comments

  On October 13, 2009, the Securities and Exchange Commission (SEC) officially extended the date for non-accelerated filers to comply with Section 404(b) of the Sarbanes-Oxley Act of 2002 (SOX) until their fiscal years ending on or after June 15, 2010. Since the adoption of the rules implementing Section 404(b) on June 5, 2003, the time period for compliance by non-accelerated filers has been extended several times. It is widely believed that this extension, for six additional months, will be the last. Companies other than non-accelerated filers are already subject to Section 404 compliance. Although “non-accelerated” filers are not specifically defined, such filers include small business entities.

  Among other things, Section 404(b) of SOX requires companies to include in their annual reports filed with the SEC, an accompanying auditor’s attestation report, on the effectiveness of the Company’s internal control over financial reporting. In other words, reporting companies must employ their auditor to audit and attest upon their financial internal control process, in addition to the financial statements themselves. One of the reasons that implementation has been delayed for non-accelerated filers, was the need for the SEC to provide guidance to both auditors and reporting companies as to how to structure internal controls, and what structure or structural deficiencies an auditor is to opine upon.

  To assist companies and auditors in complying with the new rules, the SEC approved the issuance of PCAOB of Auditing Standard No. 5 providing guidance as to the Audit of Internal Controls Over Financial Reporting that is Integrated with an Audit of Financial Statements. In addition, the SEC has issued interpretative guidance to assist management of reporting companies in complying with the internal control evaluation and disclosure requirements. See Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, Release No. 33-8810 dated June 20, 2007.

  PCAOB of Auditing Standard No. 5 together with Release No. 33-8810 was intended by the SEC to make internal control over financial reporting audits and management evaluations of ICFR more cost-effective by being risk-based and scalable to a company’s size and complexity. Whether they meet these goals remains to be scene, however, many non-accelerated filers are finding the increased auditor expense alone to be cost prohibitive, let alone setting up the mandated infrastructure to avoid negative audit comments (for example, having only one officer responsible for financial reporting alone results in negative comments, regardless of the structure in place to ensure that the single officer properly records and reports all transactions).

  The SEC has indicated that the last postponement for the Section 404(b) auditor attestation requirements for non-accelerated filers allowed time for the PCAOB to issue final staff guidance on auditing internal financial controls for smaller companies and for the SEC staff to evaluate whether their current guidance is the most cost-effective for smaller public companies. The PCAOB published staff guidance for auditors of smaller public companies on January 23, 2009 describing how auditors can apply the principles described in Auditing Standard No. 5 and providing approaches to particular issues that might arise in the audits of smaller, less complex public companies.

  The SEC directed its staff to conduct a study in order to assess whether the SEC guidance and PCAOB guidance hare having the intended effect of facilitating more cost effective evaluations. The results of this study were made public on October 2, 2009. The most recent postponement is to allow smaller public companies and their auditors to digest and implement the results of these most recent studies and guidelines.

  The SEC has made clear that they believe that all steps and guidance to implement Section 404(b) for non-accelerated filers has been completed and that auditors and small public companies should proceed forthwith to prepare to comply. That is, there will be no further delays. How these guidelines will be implemented and the additional cost to small public companies still causes great concern to those small companies that have been impacted by the recent economic downturn, which is the vast majority.

  Attorney Laura Anthony is a Florida securities attorney and the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The Florida corporate and securities attorneys of Legal & Compliance offer specialized legal services to small and mid-size private and public (OTCBB) companies, entrepreneurs, and business professionals throughout the country. Contact us today for a FREE consultation!

  Tags: due diligence, going public, non-accelerated filing, PCAOB of Auditing Standard No. 5, public shells, Reverse Mergers, sarbanes-oxley, SEC Law Firm, section 404(b), securities attorney, SOX 404(b)

• 07Oct

  Potential Impact of Rule SEC Release #34-60515 Regarding Proposal to Extend Regulation NMS Coverage to OTC Securities

  Securities Law Firm No Comments

  FINRA, in August of 2009, filed Release No. 34-60515 with the SEC. FINRA proposes to extend certain NMS protections to quoting and trading in the OTC market for equity securities.

  In summary:

  1. Restrictions on sub-penny quoting;
  2. Prohibitions on locked or crossed markets;
  3. Implementation of caps on access fees;
  4. Requirements of transparency of customer limit orders.

  FINRA’s goals, part of broadly anticipated changes in financial systems, are proposed as part of efforts to both modernize and achieve higher “quality” in the OTC marketplace.

  1. Sub-Penny Quote Restrictions

  FINRA addresses both issues of modernization and higher quality by proposing to restrict sub-penny quoting in conjunction with removing the requirement that ATS’s include non-subscriber access fees within its quote. Restricting sub-penny quoting may help prevent the practice of “stepping ahead” of displayed limit orders by trivial amounts.

  The proposal will most effect small businesses whose securities trade for under $1.00. Under FINRA’s proposal, market participants will be able to quote in increments ranging from pennies to ten thousandths of a penny depending on the price of the security. There is some doubt as to the appropriateness of this level, however, for MPVs under $1.00.

  2. Locked & Crossed-Markets Restrictions

  FINRA’s proposal requires members to implement policies and procedures to avoid locking and crossing quotations and to enable the reconciliation of locked or crossed quotations. Displaying locked quotations is inconsistent with the maintenance of fair and orderly markets and prevents market efficiency. FINRA’s proposal aims to enhance investor protections, allowing member firms to immediately post a routed order to full-display size.

  3. Capping Access Fees

  Current rules limit most alternative trading systems (“ATS”) from charging either access or post-transaction fee to non-subscribers, unless that fee is already included in the ATS’s posted quote. FINRA would improve application of the Interpositioning Rule’ by reflecting access fees. Thus, posted quotes may foster more accurate competitive price quotes, by emphasizing an order-driven market, to encourage ECN competition.

  4. Require Immediate Customer Limit Order Displays

  Will the new rules competition, provide increased liquidity, and increase transparency? That is FINRA’s hope. Under the proposal, a market maker displaying a priced quote must immediately display customer limit orders that better market displayed price and size. Requirements of displaying customer limit orders may increase quote competition and ultimately narrow spreads. The FINRA goal here, as with most of FINRA’s proposed changes, is squarely aimed at reducing transactional costs.

  Attorney Laura Anthony is a Florida securities attorney and the Founding Partner of Legal & Compliance, LLC, a national corporate, securities and civil litigation law firm based in West Palm Beach, Florida. The Florida corporate and securities attorneys of Legal & Compliance offer specialized legal services to small and mid-size private and public (OTCBB) companies, entrepreneurs, and business professionals throughout the country. Contact us today for a FREE consultation!

  Tags: due diligence, going public, OTCBB, Over The Counter Bulletin Board, public shells, Reverse Mergers, Rule 144, SEC Law Firm, SEC reporting requirements, securities attorney

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